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Security Software, Inc. Case 33
Convertibles
Purpose: The case allows the student to view the hybrid nature of convertible securities. While it would
be very difficult for the firm to issue either equity or bonds in a post-recession bear market, convertible
securities offer the opportunity to enter the market at a lower interest rate and at a higher conversion
price than the stock price the firm currently has. However, the case also illustrates the potentially
downward effect of convertibles on earnings per share. An interesting feature of the case is that it traces
stock price declines during the Internet bust.
Relation to Text: The case should follow Chapter 19.
Complexity: The case is moderately complex. It should require 1 to 1½ hours.
Solutions
b. $30 million total issue / $1,000 par value = 30,000 bonds
2. $30 million total issue / $19.50 stock price = 1,538,462 new shares
3. $30 million total issue / $35 stock price = 857,143 new shares
4
.
$30 Million.............................................................Total issue
`
5. With a conversion ratio of 40, the bonds will go up to a value of at least $1,400 (40 x $35). A
conversion premium may call for even a slightly higher value.
6. The corporation could force a conversion through calling in the bonds at close to par when they are
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
Also, a step-up in the conversion price after a specified period of time would tend to force
bondholders to convert. If the conversion price went from $25 to $30, the conversion ratio would
7
.
a. Earnings before interest and taxes...........................................................................................$15,000,000
Interest ($1,000,000 from the table in Question 7 plus $2,225,000 from the
8. The convertibles increase basic earnings per share by slightly over $.12 from $.70 to .824. Diluted
earnings per share are also up by $.175 from the initial value of $.70 to $.875. Although in this case,
assumed additional earnings and the add back of bond interest compensate for potential diluted
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
